BY THE COMPTROLLER GENERAL Report To The Chairman, Subcommittee On Economic Stabilization,Committee On Banking, Finance, And Urban Affairs House Of Representatives OF THE UNITEDSTATES Trade Offsets In Foreign Military Sales Trade offsets Involve shared manufacturing by a foreign government or other arrangements armed at “offsettlng” part of the cost of a weapon system purchased from the Unlted States Various government and prtvate Industry off+ clals have expressed concern about the In- creased use and possible consequences of offsets In foreign mtlitary sales GAO was asked to review the policies, responslbllltles, and data bases of federal agencies regarding these offset arrangements This report contains information on each of these areas It also suggests that the Congress may wish to direct the admmlstratlon to Institute a poky to resist offset demands by foreign govern- ments purchasing mllltarygoodsfrom the United States when U.S assistance IS provided. GAO belleves that foreign military sales credits or . grants should not be used directly or Indirectly to expand the Industrial base of a foreign country at the expense of the U S lndustrlal base and U S jobs. Exceptions to this general rule might be made for foreign policy reasons OAO/NSlAD-84-102 APRH. 13, 7984 COMF’TROLLER GENERAL OF THE UNITED STATES WASHINGTON 0.C 20648 B-214935 The Honorable John J. LaFalce Chairman, Subcommittee on Economic Stabilization Committee on Ranking, Finance and Urban Affairs House of Representatives Dear Mr. Chairman: Your letter of July 15, 1983, requested that we review how "offsets' in foreign militarv sales (FMS) affect the defense industrial base. Specifically, you asked us to --determine what the U.S. national policy is on offsets, --ascertain which federal agency has resnonsibil- ity for monitoring offset activities and deter- mine how aqencies coordinate the administration of offsets, --determine to what extent offsets are used in FMS and commercial transactions, and --identify what type of data base exists to track offset activities in order to determine their effect. As used in this report, the term "offset" includes any arrange- ment wherein U.S. industry shares production of a system procurement or purchases items from sources within a foreign country to o fset an established percentage of the cost of that nrocurement. f We reviewed the nolicies, responsibilities, and data bases of federal agencies regarding trade offset arrangements. We found that at the federal level: 'Offsets include coproduction, licensed production, subcontrac- tor production, overseas investment, technology transfer, and countertrade. (See anp. II for a definition of each element of offsets.) B-214935 --No comprehensive national Dolicy exists to guide federal officials or industry representa- tives in offset transactions. DOD has insti- tuted its own policy to rely on industrv market forces to requlate offsets except when industry is unable to satisfy any particular qovern- merit's demands. --There is little coordination among the agencies studyinq offsets, and no sinqle federal agency has taken the lead to ensure that the various U.S. interests are served when a U.S. firm makes an offset commitment with a foreign sovernment. --No central data base exists on offset commit- ments and complete and accurate data on offsets are not otherwise readily available. The followinq presents the hiqhliqhts of our review. Additional details on our observations, as well as our objectives, scooe, and methodoloqy, are included in aopendix I. The United States has no comprehensive national nolicv on the administration of offsets that incornorates the views of the various affected U.S. qovernment aqencies and orivate industry. Although officials at the Departments of Commerce and the Treas- ury and the Office of the U.S. Trade Representative generally aaree that such a policy is needed, they have not aqreed on how it should be administered and which aqencv should have the lead role, At present, the nearest statement of policy is DOD's directive statinq that (1) DOD will stay at arm's length in quaranteeinq offsets unless industry is unable to satisfy a for- eiqn qovernment's demands and (2) FMS credits will not be used to directly finance coproduction or licensed production abroad. The United States takes no active role in administering offset transactions, and therefore no aqency combrehensively monitors offset activity. Likewise, no agency is responsible for ensurinq that all national interests are served when a U.S. firm makes an offset commitment to a foreiqn qovernment as a condition for the sale of U.S. defense items. Coordination of the administration of offsets, to the limited extent it exists, does not involve departments such as Treasury and Commerce, which have major trade policy interests in these transactions. Althouqh limited, existinq information indicates that off- sets are a substantial element in the sale of U.S. weapons sys- tems. Moreover, developinq countries are now joininq the increasinq number of industralized countries demandinq such con- cessions. 4vailable data also suqqest the number of offset demands is increasinq and will continue to increase in the 2 B-214935 future. For example, in an August 1983 report on coproduction, DOD estimated that in the next 5 years, about $30 billion in potential arms sales are expected to involve offsets. Because increased demands for offsets have raised suffi- cient questions as to whether the practice is detrimental to the United States, several agencies have decided to further examine the issue. The Departments of State, Commerce, Defense, the Treasury and the Office of the United States Trade Representa- tive have reviewed or are reviewing and defining their positions on the use of offsets. These activities include policy reviews, analytical studies, and obtaining advice and views from industry leaders. However, these reviews are being conducted individu- ally by each department with little joint coordination. We believe it is essential that these agencies collaborate with each other and industry on the use of offsets in foreign mili- tary sales. MATTER FOR CONSIDERATION BY THE COMMITTEE In addition to the issues discussed above, there is a related issue which we believe warrants the Committee's particu- lar attention-- allowing offsets in FMS transactions which are financed by EMS assistance. Some of the countries now request- ing offsets are also receiving FMS credit or grant assistance. Although Defense has a policy that FMS credits will not be used directly to finance coproduction or licensed production abroad, there is no policy to prevent a country which has received FMS assistance, in the form of a qrant or FMS credit, from requiring an offset commitment from a U.S. firm as a condition of sale. This offset could then be used by the FMS-recipient country to expand its own industrial base at the expense of the U.S. indus- trial base and U.S. jobs. We believe that FMS credits should not be used directly or indirectly to expand the industrial base of an FMS recipient at the expense of the U.S. industrial base and U.S. jobs, especially when countries' FMS credits have a significant grant element, are forgiven, or might not be repaid, Exceptions to this general rule might be made for foreign policy considerations. We recognize that to the extent that certain _ countries build their industrial military bases, they may require less economic and military assistance from the United States. If this practice becomes widespread, in our opinion, it could run counter to U.S. interests because it diminishes the beneficial effects that advocates of FMS programs often speak of; that is, FYS assistance does not result in a substantial outflow of U.S. resources since these funds return to the United States in the form of increased demands for goods. Accordingly, the Committee may wish to consider the need for the Congress to 3 B-214935 direct that the administration institute a policy to resist off- set demands by foreign governments when FMS credits or grants are involved in the sale. As requested by your office, we did not obtain agency comments on this report. We did, however, discuss the report's contents with program officials at the Departments of Commerce, Defense, State, the Treasury and the Office of the United States Trade Representative, and their comments have been incorporated where appropriate. Also, as agreed with your office, we are sending copies of this report to the Director, Office of Management and Budget; the Secretaries of Commerce, Defense, State, and the Treasury; the Office of the United States Trade Representative; the cogni- zant congressional appropriations and authorizations committees; other interested congressional committees; and others upon request. SincFrely yours, . Acting Comptroll l/dr eneral of the United States 4 __--a-CONTENTS -- Page APPENDIX I TRADE OFFSETS IN FOREIGN MILITARY SALES 1 Backqround 1 offsets are a substantial element in U.S. contracts 2 Opinion is divided on offset effects 4 U.S. aqencies do not?have data on offsets 6 Usinq FMS credits and allowinq offsets 6 JJ.S. has no national policy on offsets 9 No federal aqency has a lead role in administerinq offsets 12 Federal aqencies roles and responsibilities under study 13 Conclusions and matters for consideration by the committee 16 Objectives, scope, and methodology 17 II DEFINITION OF OFFSET ELEMENTS 18 III July 5, 1983, Letter From The Chairman, 20 Subcommittee On Economic Stabilization, Committee On Ranking, Finance, And Urban Affairs ABBREVIATIONS AWACS Airborne Warninq and Control System DOD Department of Defense DPACT Defense Policy Advisory Committee on Trade FMS Foreiqn Military Sales GAO General Wcounting Office GATT General Aqreement on Tariffs and Trade NATO North Atlantic Treaty Orqanization OMB Office of Management and Rudqet APPFNDIX I APPENDIX I TRADE OFFSETS IN FOREIGN MILITARY SALES RACKGROUND Various officials of the Departments of Commerce" Defense (DOD), State, and the Treasury: the Office of the U.S.